Accounting and Journal Entry for Interest on Capital
Owners may seek a return on investment in the form of a fixed rate of interest to the extent of the amount employed by them in the business. In order to ascertain a true picture of the business’ profitability, it is a common practice to provide interest on capital. Journal entry for interest on capital includes two accounts; Capital A/c & Interest on Capital A/c
Interest on capital is an expense for the business and is added to the capital of the proprietor thereby increasing his total capital in the business. It is not paid in cash or by the bank.
Journal entry for interest on capital is;
|Interest on Capital A/c||Debit||Debit the increase in expense|
|To Capital A/c||Credit||Credit the increase in capital|
Provide 10% interest on capital at the end of the year to Sam. His contribution to the business is 1,00,000.
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|Interest on Capital A/c||10,000|
|To Sam’s Capital A/c||10,000|
(Interest provided at 10% on 1,00,000 at the end of the year)
This shows that the company’s interest to be paid on capital has been increased by 10,000 consequently Sam’s capital has also been increased equally because of interest earned by him on capital.
This will not be paid in cash or deposited in his bank account, although, it will increase his total capital investment in the business by 10%.